Argentina’s Economy: As Strong as it Seems?

8th February 2008
Daniel Altman

0

Photo by Emily Anne Epstein

Times of turbulence in the global economy can be tough for any country, but Argentina finds itself in a particularly difficult position. The strength of the domestic economy is uncertain, and the value for Argentina’s exports may soon drop. So how can Argentina protect itself from the slings and arrows of outrageous economic fluctuations?

Several risks are waiting to be addressed: tight credit in international markets (to the extent that Argentines can access them), lower prices and lower demand for Argentina’s exports, and difficulties stemming from the government’s exchange rate policy.

The first two risks stem from long-running trends as well as recent events. Global credit markets were awash in cheap money since the world’s major central banks slashed interest rates in the early years of this decade. Now, however, crises in the financial sector have tightened the supply of short-term loans, and long-term loans like mortgages and bonds are also starting to feel the pinch.

Though the Federal Reserve has been cutting interest rates sharply, other central banks have been too worried about inflation to follow suit. With tight credit, there will be less money available for investment in Argentina, both by foreigners and by locals. The economy will need to find new ways to attract financing at home and abroad.

Commodity prices were rising steadily during the same cheap money period, thanks to the rapid growth of emerging economies like China and India. Yet that trend, too, could be turning around. A global slowdown in economic growth means demand for crops, fuels, minerals and metals won’t grow as quickly in the next year or two, and there will be less pressure on prices. A major engine of Argentina’s economic expansion will slow down. To avoid dependence on commodity prices, the economy will need to diversify.

In the meantime, Argentina faces the risk of a continued decline in the dollar. The peso’s value against the dollar is already artificially low. With a lower dollar, maintaining that low rate will be costlier; the government would have to buy more dollars and print more pesos.

Buying more dollars won’t be easy, since the government’s budget surpluses will probably be eroded by a dip in economic activity. Moreover, the government may want to spend more or offer tax breaks in order to cushion that same dip. There will be less money in the coffers exactly at the time of greatest need.

Likewise, printing more pesos could spur faster inflation at an especially dangerous time. The rise in consumer prices may be running at an annual rate of 20% or higher, which is in a range where inflation becomes difficult to control. (Without reliable economic statistics, though, there’s no way to know how close this danger really is.)

These problems will occur to some degree even if the dollar simply stays put. Liberating the peso from its roughly 3-to-1 link to the dollar could be a necessary step, and a positive one as well. Inflation would fall as the peso rose on international markets. Exports might suffer slightly in the short term, but confidence in Argentina’s economy would rise. Investment from abroad and by Argentines would increase, most likely in industries that have been starved of funds since the crisis of 2001 and 2002.

Of course, adopting a floating exchange rate is not the only way for Argentina to become a more attractive target for investment. A serious fight against corruption is a surefire way to lure investors, as South Africa – a country of similar population and economic size – has found in recent years. Argentina currently ranks as the 105th-least-corrupt of 179 economies, below Mongolia and Tanzania, in the Corruption Perceptions Index compiled by Transparency International, a leading watchdog group.

An end to needless and unwieldy bureaucracy could also give investment a boost. In the World Bank’s Doing Business survey, Argentina sits 109th out of 178 economies for the quality of its entrepreneurial environment – below Ethiopia, Bangladesh and the Kyrgyz Republic. The country ranks 165th in the ease of licensing and 147th in the ease of hiring new workers. Clearly, there is room for improvement.

New investment would provide a foundation for long-term economic growth, and it would also help Argentina’s economy to diversify away from its commodity-heavy exporting industries. This diversification would be an enormous aid to Argentina’s resilience in times of global turmoil. Not by coincidence, it would also lay the foundation for a more stable and successful economic future.

Daniel Altman is the global economics correspondent of the International Herald Tribune. His most recent book, ‘Connected: 24 Hours in the Global Economy’, is available in Spanish from Ediciones Urano and in English from Pan Macmillan and Farrar, Straus and Giroux.